HSBC’s PLUS tied to iShares China Large-Cap fund require contrarian, short-term bullish view

By Emma Trincal

New York, July 16 – HSBC USA Inc. plans to price Performance Leveraged Upside Securities due Nov. 5, 2019 linked to the iShares China Large-Cap exchange-traded fund, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10 plus triple any fund gain, up to a maximum return of at least $12.43 per PLUS.

Investors will be exposed to any losses.

“I wouldn’t touch it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“If you’re a contrarian, that’s very attractive. But that’s not what we’re about.”

The iShares China Large-Cap ETF, which tracks Chinese stocks that trade on the Hong Kong stock exchange, is in bear market territory. Its share price closed at $42.41 on Monday, down 21.5% from its January peak of $54.00.

With three times the gains, investors can expect to earn up to 19% on an annualized compounded basis with only 6.45% in annual growth in the underlying fund. On the downside, they are “long” the fund on a one-to-one basis. It provides an advantage compared to a leveraged ETF, which would offer symmetrical leverage both up and down.

Negative outlook

With the U.S. and the Chinese government on the brink of a trade war, China could end up losing the most, said Kunhardt.

“They could be in a lot more pain than the U.S.,” he noted.

“We lose sight that China is rural. All the modern life is costal. The majority of the people live in an agrarian society in a country that has very few natural resources.

“They depend on trade for almost everything. A trade war with a major partner like the U.S. is not a great formula for long-term growth.”

Speculation

The 15-month notes however are short in duration. Does it make the notes more valuable over a 15-month period?

Kunhardt said he did not think so.

“The outlook is not good long term. Maybe that’s why they made it short. It doesn’t mean it’s not risky,” he said.

While the notes meet the “buy when there is blood in the streets,” the often-cited contrarian adage, taking such risk is not for everyone.

“Yes, it’s true. I can make money buying beaten-up stocks. I can also make money through a concentrated portfolio of stocks. But I take significant risk because it’s concentrated. As a portfolio manager, my job is to diversify. I try to limit risk,” he said. “This note is a speculative bet. I have a different approach. I give up some of the returns to manage risk.”

Long-term view

Andrew Schiff, investment consultant at Euro Pacific Capital Inc., said he is bullish on China long term.

“The problem is the short term. The ramifications of the trade war are having a very uncertain impact on equities,” he said.

“The market is very illogical right now. That’s because the consensus is that China will suffer more than the U.S. from a trade war. Therefore, Chinese equities are punished more. That’s what’s happening.”

Schiff said he disagreed with this view.

“We actually believe that the U.S. has more to lose in a trade war,” he said.

“Short term, Chinese stocks are going through a lot of pain. But we think the business-friendly attitude of China bodes well for long-term prospects.”

He said that from a macro-economic standpoint, China is not as dependent on trade as it is commonly thought.

“Seventy percent of our GDP comes from consumption, most of which are imported goods. China does not consume that much. It can satisfy its own needs,” he said.

He remained cautious however about the near-term outlook.

“It’s a harder call. Right now we’re long China but we’re very defensive,” he said.

HSBC Securities (USA) Inc. is the agent, and Morgan Stanley Wealth Management is the distributor.

The notes will price on July 31 and settle on Aug. 3.

The Cusip number is 40435X744.

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